Most Wall Street investment banks used to be partnerships. They were owned by the firm's senior employees, who invested their own money to fund the bank's balance sheet. When the bank screwed up, it came right out of their own pockets. Lisa Endlich's 1999 book, The Culture of Success, describes just how aligned the partners were with the bank's performance:
In a private partnership none of the assets of partners are shielded from liability, and the individual partners are exposed down to the pennies in their children's piggy banks ... The actions of a rogue trader could spell personal bankruptcy ...
That's changed over the last three decades. Investment banks transitioned into public companies, where the capital was largely owned by outside investors, and partners no longer held unlimited liability. That opened the doors to take new risks. Today, the last remaining big investment banks, Goldman Sachs (GS -0.45%) and Morgan Stanley (MS -0.74%), partake in practices that never would have been considered under the old partnership model.
Which raises the question: Should we go back to the old partnership model?
It's a question I've addressed before.
Last week, I asked David Cowen, CEO of the Museum of American Finance and a financial historian, what he thought. Have a look (transcript follows):
Cowen: "When those investment houses were partnership owned, it was their own capital on the line, and yeah, the commercial banks, they were always public, but now the investment banks go public and that gives them the opportunity to potentially lever lot more. If you take a look at a Lehman Brothers, and they're still in the process of unwinding all that, but 30, 35 times, 40 times possibly even leverage, would that have happened if it was the partner's money? And we know back in the day, the partners had much less leverage or capital that they've deployed in case something went wrong."